Chapter 8

Activity-based costing

Activity-based costing
A methodology that can be used to measure
both the cost of cost objects and the
performance of activities
Can help solve problems such as

distorted product costs

poor cost control

The ABC method adopted, depends on the

problems that need to be addressed

Activity-based costing terminology

Activity - a unit of work performed
Cost driver - a factor that causes cost
Resource driver - cost driver used to estimate
the cost of resources consumed by an activity
Activity driver - a cost driver used to
estimate the cost of an activity consumed by
the cost object
Cont.

Activity-based costing terminology

Root-cause cost driver - the basic factors
that cause activities to be performed and
their costs to be incurred
Bill of activities - identifies the activities,
the activity cost per unit of activity driver,
the quantity of activity drivers consumed,
and, therefore, the cost of the activities
consumed by the product

Different forms of ABC

Simple approach - includes manufacturing
overhead
ABC system for indirect costs - includes
manufacturing and non-manufacturing costs
Comprehensive system - includes all
product-related costs, except direct material

An activity-based costing model

The costing view

measuring the cost of activities

assigning activity costs to products

Activity management view

used to determine the causes of costs

The costing view of ABC

Measuring the cost of activities

assigning costs to activity centres

identify and cost the activities performed in
each activity centre

Assigning activity costs to products

calculating the activity cost per unit of activity

driver
preparing a bill of activities for each product

Activity-based hierarchy of costs

and activities
Unit-level activities
Batch-level activities
Product-level (or product-sustaining)
activities
Facility-level (or facility-sustaining)
activities

not usually included in product costs

Activity-based versus
conventional product costs
Conventional costing assumes product costs
are driven by volume-based cost drivers
Conventional costing ignores batch size units produced in large batches consume a
relatively low consumption per unit of
batch costs
ABC includes non-manufacturing costs

ABC benefits will be greatest

where...
Overhead costs are a significant proportion
of total cost, and a large part of overhead is
not directly related to production volume
The business has a diverse product range,
and individual products use of support
resources differs from their use of volumebased cost drivers
Cont.

ABC benefits will be greatest

where...
Production activity involves diverse batch
sizes and product complexity
There are likely to be high costs
associated with making inappropriate
decisions, based on inaccurate product costs
The cost of designing, implementing and
maintaining the ABC system is relatively
low due to sophisticated IT support

Impediments to introducing ABC

Lack of awareness of ABC
Uncertainty about the potential benefits from
ABC
Firms understand the need for change but are
concerned about the extensive resource
requirements to implement ABC
Resistance to change among managers and
employees

Other activity-based costing issues

Sources of variations in types of ABC
include whether

actual (past) or budgeted costs are analysed

the implementation is a one-off project or an
on-going system
cost objects, other than products, are included

Cont.

Other activity-based costing issues

Implications of excess capacity

ABC estimates the cost of resources used to

perform activities to produce and sell products,
which may not always equal the cost of
resources supplied
need to account for the costs of unused capacity
when budgeted costs have been used to
generate activity-based product costs
Cont.

Other activity-based costing issues

Behavioural issues

change can be perceived as threatening

ABC may require changes in data collected and
collection and analysis procedures

bottom-up change management may give

some degree of ownership of any changes
caused by ABC
management must be seen as committed to the
change process

Limitations of activity-based costing

If a high level of facility-level costs are
allocated to products, this can lead to an
arbitrary element of product cost
Unitised batch, product and facility-level
costs can lead to product costs that are of
limited use for decision making
The cost of updating an ABC system can be
very high, but is needed to avoid producing
outdated, irrelevant information

Activity-based costing in service

organisations
ABC can be difficult to implement in
service firms, because

high levels of facility costs cause problems with

costing services
individual activities are difficult to identify
because they are non-repetitive
a non-repetitive production environment makes
it difficult to identify service outputs

Exhibit 8.2

Exhibit 8.3

Exhibit 8.4